Sumitomo Bakelite Company Limited's (TSE:4203) Share Price Could Signal Some Risk

With a price-to-earnings (or "P/E") ratio of 18.4x Sumitomo Bakelite Company Limited (TSE:4203) may be sending bearish signals at the moment, given that almost half of all companies in Japan have P/E ratios under 13x and even P/E's lower than 9x are not unusual. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.

Recent times haven't been advantageous for Sumitomo Bakelite as its earnings have been rising slower than most other companies. It might be that many expect the uninspiring earnings performance to recover significantly, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.

View our latest analysis for Sumitomo Bakelite

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What Are Growth Metrics Telling Us About The High P/E?

Sumitomo Bakelite's P/E ratio would be typical for a company that's expected to deliver solid growth, and importantly, perform better than the market.

If we review the last year of earnings growth, the company posted a worthy increase of 8.4%. This was backed up an excellent period prior to see EPS up by 67% in total over the last three years. Accordingly, shareholders would have probably welcomed those medium-term rates of earnings growth.

Looking ahead now, EPS is anticipated to climb by 11% per year during the coming three years according to the five analysts following the company. That's shaping up to be similar to the 9.3% per annum growth forecast for the broader market.

In light of this, it's curious that Sumitomo Bakelite's P/E sits above the majority of other companies. It seems most investors are ignoring the fairly average growth expectations and are willing to pay up for exposure to the stock. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

What We Can Learn From Sumitomo Bakelite's P/E?

While the price-to-earnings ratio shouldn't be the defining factor in whether you buy a stock or not, it's quite a capable barometer of earnings expectations.

We've established that Sumitomo Bakelite currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. Unless these conditions improve, it's challenging to accept these prices as being reasonable.

Having said that, be aware Sumitomo Bakelite is showing 1 warning sign in our investment analysis, you should know about.

Of course, you might also be able to find a better stock than Sumitomo Bakelite. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.